Q2 2022 MSA Safety Inc Earnings Call

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After today's presentation, there will be an opportunity to ask questions.

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Please note, this event is being recorded.

I would now like to turn the conference over to Chris Hepler. Please go ahead.

Thank you, Chad. Good morning and welcome to MSA's second quarter 2022 conference call. This is Chris Hepler, Executive Director of Corporate Development and Investor Relations. I'm here with Nish Fartanian, Chairman, President and CEO , and Ken Kraus, Senior Vice President, CFO and Treasurer. Before we begin, I'd like to remind everyone that matters discussed during this call may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. deltas.org

Forward-looking statements include, but are not limited to, all projections and anticipated levels of future performance. And anticipated levels of future performance.

Forward-looking statements include a number of risks, uncertainties, and other factors that may cause our actual results to differ materially from those discussed today. These risks, uncertainties, and other factors are detailed in our SEC following.

MSA undertakes no duty to publicly update any forward-looking statements made on this call except as required by law.

We have included certain non- GAAP financial measures as part of our discussion this morning and the non-GAP reconciliation as well as our second quarter press release are available on our investor relations website at investors.msafsafety.com

Moving on to today's agenda, Nish will discuss key highlights of the quarter and then turn the call over to Ken to discuss our financial performance. Nish will then provide closing remarks.

Following our prepared remarks, we will open the call for questions. With that, I'll turn the call over to Nish.

Thank you, Chris, and good morning, everyone. Before getting into the details of the quarter, I'll start today's call by sharing some information that has all of us at MSA very excited.

Within the past several weeks, we were able to finalize significant breathing apparatus contracts with two of the most recognized fire departments in the world. As you may have read in our recent press release, the Los Angeles County Fire Department has selected the G1 SCBA as its new respiratory protection system.

Then, following up that exciting news, we learned that the London Fire Brigade selected the MSA M1 SCBA as its new breathing apparatus of choice.

You can find more information on that contract in our press release issued Tuesday.

Today the MSA brand is a global leader in the fire fighter safety market and we're grateful for the trusted LA County and the London Fire Brigade continue to place in us.

Both wins are excellent examples of cross-selling to existing customers who already know MSA from fire protective clothing and helmets. And as you know, a key element of our strategy is to protect the firefighter from head to toe.

Through a combination of product development initiatives and inorganic investments and well-established brands like Globe and Bristol, our team continues to advance that strategy.

When we look at our business more broadly, overall demand continued to be very strong in the quarter across most all of our core products and markets. The orders were up 15% in the quarter on a constant currency basis. The orders were up 15% in the quarter on a constant currency basis.

and 10% organically.

Book the bill continued to trail trend well above one time again this quarter. And in July we continue to see good growth and orders over the prior year.

Our quarterly revenue, which continues to be restrained by supply chain issues, was $373 million, up 9% from a year ago on a reported basis, and 12% on a constant currency basis.

Currency translation was a 3% headwind in the quarter.

Ken will discuss this in more detail in his remarks.

Backlog at quarter-end was again at a record level of over $400 million as a result of strong demand and ongoing supply chain issues.

Backlog has increased steadily over the past year and a half and is up across all product categories.

Supply chain and inflation continue to be factors, and we expect this to persist in the near term. As anticipated, supply chain issues were most pronounced in electronic components in our gas detection business.

Our teams are working on a number of initiatives to address these challenges.

We continue to build supply chain resiliency, especially for electronic components by engineering redesigns to increase flexibility for high risk components, as well as qualifying, alternative components and suppliers. We continue to build supply chain resiliency, and for suppliers. We continue to build supply chain resiliency, and for suppliers.

and we're using more technology to get better visibility to future availability of components.

We're also considering greater insourcing for certain key components and we're consciously building, select inventory, to serve our customers in high demand areas.

As we see it, building inventory is a good use of our strong balance sheet in this challenging environment to ensure we can respond to our customers' expectations.

All things considered, I remain very optimistic around the fundamentals of our business and the durability of customer demand for MSA products and solutions.

Shifting gears a bit, in June we published our annual Corporate Social Responsibility Report. As I've said on many occasions, Corporate Social Responsibility is at the heart of what we do at MSA.

Our mission is to keep the world's workers safe each and every day so they may return home safe to their families.

As I reflect on our progress on energized, about both our vision for the future of worker safety and the next steps in our CSR journey. And the next steps in our CSR journey.

We continue to make investments in product services and connected worker solutions that re-imagine the next generation of worker safety.

We also continue to enhance our programs around environmental sustainability and talent, as well as various risk reduction programs such as the supply chain resiliency programs I just talked about.

We do this because at MSA, we know these are the kind of investments that help us to build a better business model in these times.

Our people continue to bring passion for our mission, which inspires us to design, develop, and manufacture to world's best safety solutions that protect people who put their trust in the NSA brand.rett Putin himself effectively provokes some policies

So while I'm very pleased with our results this quarter, our journey continues to make our company, our associates and our customers fit for the future.

With that, I'll now turn a call over to Ken for his comment.

Thanks Nish and good morning everyone. On today's call I'll provide a recap of our second quarter financial performance and review key balance sheet and cash flow metrics.

Quarterly sales were $372 million, up 9% on a reported basis. On a constant currency basis, Quarterly sales were up 12%, and 8% organically, driven by both price realization and improvements in volume.

Currency translation impacted consolidated sales by 3% this quarter, largely due to Euro and British pound exposure in our international business. FDA? goods

Orders were very strong in the quarter across the portfolio, about 15% on a constant currency basis over last year. About 15% on a constant currency basis over last year.

Organic orders also showed double-digit improvement reflecting healthy trends across both price and volume.

Quarterly book to bill was in excess of 1.1 times. And we saw double digit year over year growth in orders each month throughout Q2 and continue to see a robust order pace into July .

While we saw strong sales and order growth in the quarter, supply chain issues continue to constrain our growth and drive up our backlog.

As Nish had mentioned, we finished the quarter with record backlog driven by robust customer demand and ongoing supply chain challenges.

Backlog was up by another $50 million from the first quarter.

The increase was primarily a tribute to SCBA firefighter protective clothing and gas detection.

Now turning to profitability. Gross profit was 44.2% of sales in the quarter. Acquisition related intangible asset amortization impacted gross margin by 60 basis points in the quarter.

Adjusting for amortization in both periods, quarterly gross margin was down slightly on a year-over-year basis.

This was driven by higher inflationary pressures and product warranty charges offset by improved pricing, especially in the Americas segment.

Pricing remains at the top of our agenda and our team is focused on managing the price cost equation.

SGNA expense in the quarter was $86 million or 23.1% of sales, up $3 million from the prior year.

The increase was largely attributable to higher employee wages and costs associated with increased business activity.

As a percent of sales, we realized strong leverage in SG&A on the double-digit sales growth, which offset the gross profit headwinds I mentioned previously.

Reported Operating Margin was 16.5% up 620 basis points over the prior year. On an adjusted basis, Operating Margin was 17.6% up 40 basis points on margin accretion from back rack. Up 40 basis points on margin accretion from back rack.

With that, I'll provide a closer look at our segment performance.

In our America segment, we had strong growth in sales up 16% or 10% organically. Adjusted operating margin was 22.6% in line with the prior year.

In our international segment, sales were down 3% on a reported basis, but up 5% in constant currency or up 2% in organic constant currency terms. In the last few years, sales were down 3% on a reported basis, and up 5% in constant currency terms. In the last few years, sales were down 3% on a reported basis, and up 5% in constant currency terms. In the last few years, sales were down 3% on a reported basis, and up 5% in constant currency terms.

The quarterly currency translation headwind was significant at 8% on the weaker euro and pound that I mentioned previously.

Adjusted operating margin was 14.3% down 220 basis points from last year due to unfavorable currency headwinds, large orders and higher input costs impacting gross profit offset partially by improvements in SG&A performance.

We continue to see very good leverage in international SG&A from our restructuring programs that we've executed over the past couple of years.

Gap net income was $48 million or $1.21 in earnings per share compared to the first year.

on an adjusted basis, adding back and both periods product liability expense, restructuring and similar items, net income was $51 million or $1.29 in adjusted EPS, which was a 22% increase over the prior year on the 9% increase in reported sales. on the 9% increase in reported sales.

Just over a year ago now, we completed the acquisition of Bacarack. Bacarack expanded our gas detection business into new applications and expanded our addressable market.

The business is performing very well. The man is strong and back log is robust.

Margin performance has been very strong, quite frankly, ahead of our expectations with adjusted operating margins trending just under 30% for the quarter and your-to-date periods. Margin performance has been very strong, quite frankly, ahead of our expectations with adjusted operating margins trending and your-to-date periods. Margin performance has been very strong, quite frankly, ahead of our expectations. Margin performance has been very strong, quite frankly, ahead of our expectations. Margin performance has been very strong, quite frankly, ahead of our expectations.

Turning to cash flow and the balance sheet, quarterly free cash flow was four million dollars. Free cash flow was impacted by an increase in working capital, notably inventory and receivables, in response to strong customer demand and ongoing supply chain bottlenecks and receivables associated with strong shipping at the end of the quarter.

Inventory is up approximately $60 million from year end on the over $100 million increase in backlog.

Given the dynamic nature of the supply chain and availability of certain components, we are investing in inventory to help deliver our backlog. We do expect to see improvements in inventory as we expect to see sequential strengthening in the second half revenue performance versus the first half. We are investing in inventory to help deliver our backlog. We are investing in inventory to help deliver our backlog.

Quarterly capex was $12 million. We paid $18 million of dividends to shareholders and deployed $28 million to repurchase shares during the quarter.

At the end of the quarter we had cash of $134 million and net debt of $489 million, or 1.6 times, adjusted EBITDA for the trailing 12 months.

Our second quarter performance demonstrated the strength of our diversified business.

As we navigate through an increasingly uncertain economic environment, our teams continue to focus on getting product out the door and managing the price-cost equation.

We entered the second half of the year with solid underlying demand in our end markets and a robust backlog.

Our strong balance sheet positions us well to invest in our business and provides good optionality as we continue to focus on execution and driving long-term profitable growth for our shareholders..

Before wrapping up, I just want to comment on our outlook.

Despite the dynamic macro environment,

Our end markets remain very healthy.

Funding in the fire service is healthy, the OGP market is supported by strong commodity prices and construction and utilities are performing well.

That said, there are increasing risks of a recession in many of our key regions. As such, our internal planning continues to consider a range of economic scenarios and we are prepared to take actions in the event we see a softening in our business.

With that, I'll turn the call back over to Nish for closing remarks.

Thank you, Ken. I've been closing, I want to highlight a couple of things. I've been closing, I want to highlight a couple of things.

We certainly acknowledge the growing economic uncertainties from rising interest rates, high inflation, and recession risks. But I remain very confident in the fundamentals of our business and our team's ability to work through the challenges of today's macroeconomic environment. The challenges of today's macroeconomic environment.

Our end markets remain healthy and robust underlying demand for our products and technologies continued in the second quarter and well into July .

And we entered the second half with a record backlog and a very healthy balance sheet, which we're putting to work building some inventory and high demand product areas to better serve customers who put their trust in the NSA brand. The better serve customers who put their trust in the NSA brand.

I look forward to our team executing our plan in the second half to continue to bring strong results.

I thank you for your interest in MSA, and at this time, can an aisle be glad to take any questions you may have?

We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone.

If you're using a speaker phone, please pick up your hands up before pressing the keys.

To withdraw your question, please press star then 2.

At this time, we will pause momentarily to assemble our ruster.

And the first question will be from Stanley Elliott from Steve Ford. Please go ahead.

Good morning Ken Nish. Thank you very much for the time. Congratulations on the quarter. Thank you Dan. Good morning. Could you all talk about what you're seeing within the Americas? I mean the breathing apparatus of 26% head protection of 18. If some of that just supply chain may be catching up a little bit for you all, just curious how to balance that kind of thinking about the rest of the year.

So, Stanley, the end user markets are really strong. The oil and gas industry is strong. As Ken mentioned, the construction industry continues to do quite well for us. General industrial business is good, along with utilities. So that drives an awful lot of the hard hat business, portable gas detection business that we're seeing. We continue to see good demand for fixed gas and flame detection products. And as you know, we're restrained in getting that out the door. We expect to see that improve over the second half of the year. And the fire service business is just really well funded. We see the opportunity pipeline.

has been very strong for us and we're starting to realize some of that business as you heard with L. A. County Fire Department. We realized some other decent sized orders and of course now we're going into the assistance, the firefighter grant season. So those funds are going to begin to be released here in the second half of the year. So we should see good demand for breeding apparatus over the back half of the year. So you know overall the end user markets are really good. It's not a matter of distributors restocking or any situation like that because a number of our products as you know.

they're built to order. So we don't see a whole lot built into that backlog. Just the overall environment is pretty strong for us. You know Stanley, if I could put a finer point on it, what I would also say, looking at the financial performance and using a bit more data, the America segment book to bill ratio was north of 110% and breathing apparatus, even despite having 26% constant currency revenue growth has a book to bill of north of us.

the FXP, so you're just kind of putting all those together. Help us with the wins. Very nice to see a lot of the investments you guys made on the SEPB ASI. And should you start to see the flow through for either for LA or for London?

So the LA order will ship for the most part in the third quarter. We expect to start shipping those in...

late August , maybe September , so we should see most of that order go in a third quarter. Some of it may stray into the fourth quarter based on you know the customer expectations and what they're looking for. London will probably start to ship beginning in the fourth quarter and that'll extend into actually the second quarter. They have laid out a delivery schedule for us and continue to refine that so we expect that to be spread out over three quarters.

And then lastly, you know, hearing concerns about, you know, manufacturing, especially in Europe , with energy costs, etc., you know, how big of a concern is that for you all, you know, maybe some of the things you all can do to kind of help mitigate some of those higher costs over there.

So we continue to analyze the situation in Europe . We're staying close to it, obviously, with some of the challenges that might arise due to pure economic impact of a recession in Europe , and then secondly, the impact that that might have on our supply chains and inflation. So we continue to look at some alternative solutions to where we are sourcing some products out of Germany to have secondary resources. And we continue to look at the

strengthening and working with some of those suppliers and making sure we stay close to them to work on supply chain there. And that's where we're not shy about building some inventory. We talk about building inventory and using the balance sheet to build inventory, where we have the opportunity to do that to offset some of those unknowns in the marketplace. We'll certainly do that Stanley.

Perfect guys, thank you very much for the time. Best of luck.

And the next question is from Larry DiMaria with William Blair. Please go ahead.

Good morning, everybody. Good morning, everybody. Nice job in that work.

Question, incremental is real bit below what we expected, but still obviously overall could perform with giving that chop environment, but you just talked your ability to hit those mid-30s incremental from the second half, which I think we're all hoping for, but you just give some color on that.

Yeah, that's a great question, Larry. And thank you for the question. This is Ken. As we look at the back half of the plan, we do feel like we have an opportunity to get back to that level of incremental margin profile that you identify. And in fact, our internal plans indicate us doing that. So we certainly think it's very realistic. When we think about the second half and some of the drivers associated with that, as we've talked about on that.

in some of our prepared commentary. The one point that we want to emphasize is we do expect a sequential stronger second half in terms of revenue performance. And if we do see that come through, which we do have confidence in that, we do expect to see a significant leveraging across our business, across SG&A. We don't see major drivers of SG&A increasing sequentially between now and the second half.

And so that additional revenue volume that would come through would certainly help boost the incremental margins to a much higher level. First, secondarily, product mix would certainly have an impact. And when we look at our backlog, we look at our business, the products that we, the gas detection products, for example, some of our higher margin products are certainly being hampered by some of the supply chain challenges. So if we do see that improve into the second half, that also will be...

a bit of a tailwind in our incremental margin profile. That's very helpful, thanks. And should we consider it still in incremental margin builds through 3Q to 4Q, or hopefully hit those numbers, both quarters, or is it kind of fourth quarter heavy? Any question? You're obviously at a good fourth quarter. Any question? Any question? Any question? Any question?

You know, I think that when you look at the business and you look at historically how the business profiles in terms of seasonality, Q3 is normally a pretty healthy quarter. We expect it to be healthy. However, Q3 also is impacted by European holidays and other sorts of events. But we do have some confidence in our ability to see high mid-single year over year growth and low double-digit year over year growth.

versus what we saw here historically.

Perfect, thanks. And then secondly on the new winds, I think you called that 9 million for London, can you just put some perspective, is this a, is that the start, is there a possibility for you know, bringing on turnout gear and you know, how's lunar doing, is lunar an option, or just you know, kind of put some perspective and if that's the start of what could happen in London and LA or if that's the entirety?

It's a layer to beauty of both departments. So one with LA, LA has been an MSA customer for turnout gear. So they've been a user of globe turnout gear for many years and that helped us to build our relationship. And we, you know, that helped us to build our relationship.

in LA to win that business and you know, that's part of the cross-selling advantage we have with covering a firefighter from head to toe. So that's what we saw on that date. LA had ordered all their units with integrated thermal imaging cameras, the ITIC. They are evaluating and will continue to look at lunar as an opportunity. You know, that would be a longer-term project with Los Angeles because of the size of the department, the magnitude and putting that into their SOPs.

So they chose to go with the ITIC. The LA, the London Fire Brigade, they were also a Bristol uniforms customer. And so again, able to leverage some of those relationships to help us with that business with some of the familiarity with the customer. And they have their own type of unit that they use very specific to the London Fire Brigade. That million dollars is for all of the business for London.

But what we do anticipate is surrounding departments to follow London. You know, this is our first major win in the UK and a number of departments are looking to London and what they did with their choice of breeding apparatus. So we certainly expect that this is going to help us with our business profile in the UK, probably Scott Lennieiroland and some of the other countries in that region. You know, just as the win with Boston helped us with the Northeast part of the US.

So it's a pivotal win for us, a number of departments around the world, looked at that win. London's also taking a look at lunar and find the technology intriguing. But again, for a large department like that, that would be a much longer term decision due to putting that into their SOPs and rolling out a major change in product like that. So those opportunities continue to be out there for us.

Okay, great call. Thanks and good luck. Thank you. Thank you, Larry.

And again, if you have a question, please press star then one.

The next question is from Rob Mason from Baird. Please go ahead.

Yes, good morning. I just wanted to see if you could update us on, I guess your pricing plans for the second half of the year. You mentioned, along with supply chain components, you know, still being a challenge at times, inflation as well. I'm just curious what you're seeing on the inflationary front and whether it's triggered, you know, any additional thoughts around adding price.

So Rob, we did see inflation kind of.

Tempored down a bit in the second quarter. You know, we had higher inflation in the first quarter and it came down a bit in the second quarter as far as the pace of inflation. But in the U.S., in North America, we implemented a price increase in April . We have one plan. We in June , price increase in June for our international organization. And we continue to evaluate if there'll be a need for additional pricing increases in the back part of the year. For additional pricing increases in the back part of the year.

So clearly we're still catching up to the pricing. The price cost equation, we're still playing catch up to some of that. And so we expect that obviously the April and the June price increase will come through here in the next couple of quarters. And we're going to, if we need to, we'll certainly push the button on increases later in a year. The US did a, the North American organization did an off-cycle price increase in November . So that's something we're discussing based upon what we see in.

as far as inflation in the supply chain as we go forward. You know, just perhaps relatedly, Nish, you mentioned AFG funding cycle about to get underway. Any prospects for inflation to be accounted for in some of the thresholds around products? I guess the funding levels themselves may be fixed.

But, you know, could that, anything that could help you on that front, deal with the inflation or the customer deal with inflation as well.

A really insightful question. We are in fact working with the administration on pricing and increase in pricing and they have just recognized when we brought it to their attention, you know, the fact that all manufacturers are seeing inflation in the supply chain and we are working with them to up the limits on the amount that the fire departments can spend on turnout gear, breathing apparatus, etc. So they're aware, we'll probably see that worked into the cycle for 2023.

but they're certainly aware of it. We're working with them on it. But they're still room, in the current funding pricing levels for them to purchase the breeding apparatus. And again, a number of departments, municipalities will supplement some of those dollars with local dollars.

them on it. But there's still room, you know, in the current funding pricing levels for them to purchase the breeding apparatus. And again, a number of departments, municipalities will supplement some of those dollars with local dollars. So we are working on it.

Sure. It just may be the last question around some of the supply chain challenges component availability. The supply chain challenges component availability.

At one point, we were speaking to fixed gas flame to all the gas detection products and SCBA. I'm not hearing as much around SCBA now and your volumes are arising. Has SCBA been solved?

I wouldn't use the word solved. I would say that we're in a much better position with that CBA.

We, our suppliers have met their commitments, certainly through the second quarter and supplying us with components, the outlook for Q3 and 4 is good. But, you know, what we can say about supply chains today is that they're consistently inconsistent. And we're certainly going to get surprises along the way. But right now, the supply chain looks good for breeding apparatus. And we hope that that continues to the balance of the year because obviously we have a nice backlog and want to get that out the door.

As far as fixed gas and flame detection, we've talked about the self-help and qualifying alternative electronic components. We certainly hope to see some volume come through on what we call the X&S 5000. That's the mainstay of fixed gas and flame detection line. We believe that we should be able to get those out in volume here starting in the third quarter and certainly larger volumes in the fourth quarter. So that should improve.

as we work through the year here. But again, there's always the risks and supply chains and people even commitment.

Sure, sure. That's helpful. Thank you, Nish. Thank you for your interest.

Ladies and gentlemen, this concludes our question in the answer session. I would like to turn the conference back over to Chris Hepler for any closing remarks. I would like to turn the conference back over to Chris Hepler for any closing remarks.

Thank you for joining us this morning. If you missed a portion of the conference call, an audio replay and transcript will be available on our Investor Relations website for the next 90 days. We look forward to speaking with you again soon. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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